Oil to find firmer footing as US shale output falls

However, shale technology itself has a unique characteristic and limitation that could lend support to the oil market in 2016. 

Unlike a conventional oil well, shale wells tend to be small and operated by independent producers. The life of a shale oil well tends to be far shorter than that of a conventional well, with production typically declining by 75 per cent in its first year of operation unless investment is maintained. 

Oil prices fell sharply in the final quarter of 2014 and stayed low throughout 2015. As prices fall, investment and drilling activity declines and production soon drops as well. 

Assuming investments ceased in the past year, we can expect a steep decline in the shale-oil supply in 2016. The process of supply adjustment has been under way for several months. The number of US oil rigs has fallen by more than two-thirds from 1,600 in 2014 to around 540 now.

Besides technological limitations, the tightening of financial conditions will also play a crucial part in removing supply glut from the global oil market. 

US shale producers, which usually have high leverage and limited cash flows, rely mostly on the high-yield junk-bond market to raise capital needed to maintain operations. As the US Federal Reserve has started to raise interest rates, investors are pulling money out of the high-yield bond market and shale producers are now facing difficulty obtaining financing, or even bankruptcy.

 

Komsorn Prakobphol is head of strategy at the Tisco Economic Strategy Unit. He can be reached via www.tiscowealth.com or [email protected].